What is greenfield venture advantages and disadvantages?

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Greenfield Investment Example
Advantages of Greenfield Investments
Disadvantages of Greenfield Investments
Important Points
Recommended Articles
Green investment examples
Toyota Motor Corporation
Advantages and disadvantages of greenfield investments
Disadvantages
Key takeaways:
Connected Business Concepts

Greenfield investments are a type of foreign direct investment where a company starts its operation in the other countries as its subsidiary and invests in the construction of offices, plants, sites, building products, etc., thereby managing its operations and achieving the highest level of the controls over its activities.

Greenfield Investment Example

Suppose there is a company ABC Inc. which is having its headquarters in the US. The company conducts research to know the demand for its product in the country of India. After conducting the research in the Indian market, it is found that there is a huge demand for the product of the company in India, and it can get a good customer base over there. So, the management of the company decided to expand its business by creating its subsidiary company in India and starts the operations there from the ground level by constructing new production facilities, distribution hubs, and the offices.

This investment by the company ABC Inc. in the other country by creating a subsidiary over there will be considered as the greenfield investment as the company starts its operations there from the ground level by constructing new production facilities, distribution hubs, and the offices. Also, the company will be managing all the operations using its own staff and not just investing its money, unlike in case the other type of foreign direct investmentA foreign direct investment (FDI) is made by an individual or an organization, into a business located in a foreign country. The host nation receives job creation prospects, advanced technology, a higher standard of living, infrastructural development, and overall economic growth.read more where the day to day operations are being managed is not managed by the investing company. So, this is the example of the Greenfield Investment.

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Source: Greenfield Investment (wallstreetmojo.com)

Advantages of Greenfield Investments

It helps to gain high-quality control and management of brand image. Investors of the Greenfield investments are offered with a high amount of control over the venture.
It creates a job for the people if the country in which Greenfield investments take place because when the operations are being set up in a different country, then most of the staff are generally being recruited from that country only, thereby increasing the employment of that country.
Requirements for intermediary under a Greenfield investment are removed completely, resulting in a high amount of control over the whole project as well as independence, which is beneficial for the company who is investing its money in other countries.
Customers and potential clients will get a good impression that the company is committed to the market and the environment.
Press opportunity increases since the company making a Greenfield investment are opening a new but old business branch and that too in another country.
Implementation of long term strategy due to greenfield investments becomes easy, while the company becomes lucrative to changes and opportunities around it.
Companies entering the new market through Greenfield investment obtains total dominance over the products and services manufactured or sold or provided by them since such a company is already strong financially as compared to other companies.

Disadvantages of Greenfield Investments

It requires a huge amount of capital expenditureCapex or Capital Expenditure is the expense of the company's total purchases of assets during a given period determined by adding the net increase in factory, property, equipment, and depreciation expense during a fiscal year.read more, which requires a huge amount of borrowings and loans, and therefore the interest burden is very high.
It involves venturing a project outside the country of incorporation; planning, direction, and coordinating becomes very difficult. Hence overall management may not be handled effectively.
The country in which Greenfield investments are made may face adverse consequences since the income of domestic companies transfers to subsidiaries of foreign companies.
High fixed costs are involved in making an investment in another country by the parent companyA holding company is a company that owns the majority voting shares of another company (subsidiary company). This company also generally controls the management of that company, as well as directs the subsidiary's directions and policies.read more.
If there are Discouraging government policies in the country in which Greenfield investment takes place, then the foreign investor may not make their investments in that company as the government policies will become a hurdle for achieving their goals.
Involves a huge amount if entry cost. Thus there is a high entry barrierBarriers to entry are the economic hurdles that a new entrant must face in order to enter a market. For example, new entrants must pay fixed costs regardless of production or sales that would not have been incurred if the participant had not been a new entrant.read more cost in install a venture with land, building, factories, labors, etc. Hence if the project is unsuccessful, then the parent company may incur a huge amount of loss that may make the company bankrupt.
Greenfield investment is considered to be the riskiest among others; hence companies may be reluctant to make the same.

Important Points

Conclusion

Greenfield investments are nothing but one of the types of foreign direct investment in case of which a company starts its operation in other countries from the ground level. Requirements for intermediary under a greenfield investment are removed completely, resulting in a high amount of control over the whole project as well as independence, which is beneficial for the company who is investing its money in other countries, but at the same time, greenfield investment requires a huge amount of capital expenditure which requires a huge amount of borrowings and loans and therefore the interest burden is very high.

Also, it involves venturing a project outside the country of incorporation; planning, direction, and coordinating becomes very difficult. Hence overall management may not be handled effectively. So, the decision for the investment should be taken after proper analysis of the market and considering the various risk and opportunities available.

Green investment examples

Greenfield investments differ from brownfield investments, where the company purchases or leases existing infrastructure for the same expansionary purpose. The strategy is commonly employed by companies who desire more control over their operations and want to avoid the extra costs associated with intermediaries.

In this section, let’s take a look at some real-world examples:

Toyota Motor Corporation

In 2015, Toyota announced it would be building a new production facility in the Mexican state of Guanajuato. The factory, which would produce the Corolla mid-size sedan, was slated to cost around $1 billion.

Hyundai

South Korean auto manufacturer Hyundai made a similar commitment in 2006 when it received approval to build a factory in the Czech Republic. The factory opened three years later with an initial capacity of 200,000 vehicles per year, with the Czech government providing incentives to attract Hyundai in the hopes of lowering unemployment and stimulating economic activity in the country.

Weber

In 2021, American outdoor cooking innovation and technology company Weber opened its first manufacturing and distribution hub in southern Poland. The 50,000 square meter facility allows the company to produce high-quality barbecue products for the European market and improve its delivery and service speed in the process.

Advantages and disadvantages of greenfield investments

Advantages

Control – as noted earlier, greenfield investments tend to be associated with more control since the company can build its infrastructure to spec without the need to adapt or retrofit. This also the company more control over the quality of its products.
Brand reputation – in some cases, a company that commits to establishing a presence in another country and recruits local expertise will enjoy a superior brand reputation. It may also be able to profit from stronger local networks and partnerships.
Economic benefits – greenfield investments also come with several economic benefits. Companies sometimes receive incentivization from governments in the form of tax breaks and subsidies and may be able to bypass trade restrictions and import tariffs.

Disadvantages

Capital expenditure – greenfield investments require vast sums of money which exposes the company to more risk should the project become unviable for whatever reason. If nothing else, the capital expenditure required is a substantial barrier to entry.
Political risk – while a government may initially be supportive of greenfield investment, this can change after an election if a new government takes power and is less supportive of international companies operating within its jurisdiction.
Regulations – some countries will also require that the foreign company use domestically manufactured components or services to support their operations. Others will require that a certain percentage of the workforce be comprised of local employees. These requirements can make a greenfield investment problematic for companies that must control every aspect of the process to maintain exacting standards.

Key takeaways:

A greenfield investment is a form of foreign direct investment where a company establishes operations in another country by constructing new facilities from scratch.
Real-world examples of greenfield investment include Toyota in Mexico, Hyundai in the Czech Republic, and Weber in Poland.
Greenfield investments can afford the company more control over its foreign operations and grant access to various financial incentives. However, the significant capital expenditure represents a substantial barrier to entry and can make the company more vulnerable to a change in government or regulations.

Connected Business Concepts

Circle of Competence

The circle of competence describes a person’s natural competence in an area that matches their skills and abilities. Beyond this imaginary circle are skills and abilities that a person is naturally less competent at. The concept was popularised by Warren Buffett, who argued that investors should only invest in companies they know and understand. However, the circle of competence applies to any topic and indeed any individual.

What is a Moat

Economic or market moats represent the long-term business defensibility. Or how long a business can retain its competitive advantage in the marketplace over the years. Warren Buffet who popularized the term “moat” referred to it as a share of mind, opposite to market share, as such it is the characteristic that all valuable brands have.

Buffet Indicator

The Buffet Indicator is a measure of the total value of all publicly-traded stocks in a country divided by that country’s GDP. It’s a measure and ratio to evaluate whether a market is undervalued or overvalued. It’s one of Warren Buffet’s favorite measures as a warning that financial markets might be overvalued and riskier.

Warren Buffet Companies

Warren Buffett is an American investor, business tycoon, and philanthropist. Known as the “Oracle of Omaha”, Buffett is best known for his strict adherence to value investing and frugality despite his immense wealth. He is among the wealthiest people in the world. Most of his wealth is tied up in Berkshire-Hathaway and its 65 subsidiaries.

Price Sensitivity

Price sensitivity can be explained using the price elasticity of demand, a concept in economics that measures the variation in product demand as the price of the product itself varies. In consumer behavior, price sensitivity describes and measures fluctuations in product demand as the price of that product changes.

Price Ceiling

A price ceiling is a price control or limit on how high a price can be charged for a product, service, or commodity. Price ceilings are limits imposed on the price of a product, service, or commodity to protect consumers from prohibitively expensive items. These limits are usually imposed by the government but can also be set in the resale price maintenance (RPM) agreement between a product manufacturer and its distributors.

Price Elasticity

Price elasticity measures the responsiveness of the quantity demanded or supplied of a good to a change in its price. It can be described as elastic, where consumers are responsive to price changes, or inelastic, where consumers are less responsive to price changes. Price elasticity, therefore, is a measure of how consumers react to the price of products and services.

Economies of Scale

In Economics, Economies of Scale is a theory for which, as companies grow, they gain cost advantages. More precisely, companies manage to benefit from these cost advantages as they grow, due to increased efficiency in production. Thus, as companies scale and increase production, a subsequent decrease in the costs associated with it will help the organization scale further.

Diseconomies of Scale

In Economics, a Diseconomy of Scale happens when a company has grown so large that its costs per unit will start to increase. Thus, losing the benefits of scale. That can happen due to several factors arising as a company scales. From coordination issues to management inefficiencies and lack of proper communication flows.

Network Effects

A network effect is a phenomenon in which as more people or users join a platform, the more the value of the service offered by the platform improves for those joining afterward.

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